US Federal Reserve spooks markets with rate rise talk

The US Federal Reserve has signalled that it may raise interest rates sooner than many analysts had previously expected.

In her first major decision since taking over as the world's most powerful central banker, Janet Yellen was trying to send a clear message.

If the US recovery continues, the Fed's economic stimulus or money printing will evaporate later this year, and rates could rise months thereafter, meaning the era of official interest rates between 0-0.25 per cent could soon be over.

However, Dr Yellen says there is no preset course, and signalled that significantly higher rates in the United States was a long term ambition that was conditional on continuing good news.

"Even after we've had an accommodative monetary policy for long enough to get the economy back on track in the sense of meeting our objectives, the stance of policy that will be appropriate to accomplish that will be easier or involve somewhat lower than would be normal short-term interest rates," she said.

"Now, eventually, years later, most people think they will go back up but, as you said, that suggests the path will be gradual."

There was one big question at this morning's packed press conference - after the quantitative easing bond buying stops, probably later this year, just when will the Fed move to raise rates?

"Probably means something on the order of around six months, or that type of thing, but, you know, it depends, what the statement is saying is it depends what conditions are like," Dr Yellen replied.

It is becoming more apparent that those "conditions" are driving the Fed's optimism.

Today it dropped a jobless rates of 6.5 per cent as a key threshold for rate increases, given that unemployment is falling faster than expected.

The Fed's economic stimulus program has also been cut by another $US10 billion to $US55 billion a month.

If the cuts continue at this rate, the money printing will end in September.

Caution remains

However, Janet Yellen was keen to remind the overly optimistic that, five years after the collapse of Lehman Brothers, life for many Americans remains tough and that any recovery is coming from a very low base.

"Many households are undergoing balance sheet repair. There are many underwater mortgage holders," she observed.

"The difficulties, therefore, in gaining access to credit, for example from equitable lines of credit, for some that makes it difficult to finance small businesses. Mortgage credit is very difficult for those still to get without pristine credit scores."

Ethan Harris, an economist at Bank of America, says Janet Yellen's caution is well placed.

"You had a major bank and real estate crisis, you've had damaged balance sheets. The main effect of low interest rates from the Fed up until now has been balance sheet repair. Everyone's refinanced, banks are in better shape, the household sector is in better shape," he said.

"That repair process has distracted attention I think from growth. The hope is that the repair process is now well advanced and we can start seeing some better growth out there."

Inflation in the United States is stuck at 1.2 per cent - compared to Australia's 2.6 per cent - meaning the Fed has the unusual challenge of working to get inflation higher.

"If inflation is persistently running below our 2 per cent objective, that is a very good reason to hold the funds rate at its present range for longer," said Dr Yellen.

The freshly minted Fed chair was also asked about the crisis in Ukraine after reports that Russia had sold $US100 billion in US Treasuries in retaliation for US and EU sanctions.

Dr Yellen said she was unaware of any Russian selling, but confirmed the crisis is firmly on the Fed's radar as a potential risk.

"We're not seeing broader global financial repercussions but, if this were to escalate, that would certainly be something that would be on our radar screen, but we're not seeing that now and we're monitoring closely," she added.

Wall Street investors initially sold heavily on the rate rise speculation, but the Dow Jones Industrial Average ended just 0.7 per cent lower after investors absorbed the pre-conditions to lifting rates.

The US dollar surged on the renewed economic optimism and prospect of tighter monetary policy, and that saw the Australian dollar fall almost one US cent.

The Australian dollar had fallen further in local trade this morning, and was worth 90.16 US cents by 2:53pm (AEDT).